Week in Review

If you ever traveled to a foreign country you know what you had to do before buying foreign goods. You had to exchange your currency first. That’s why they have currency exchanges at border crossings and airports. So people can convert their currency to the local currency. So they can buy stuff. And when traveling people liked to go to areas that have a weaker currency. Because a stronger currency can get more of a weaker currency in exchange. Allowing your own currency to buy a lot more in that foreign country. And it’s the same for buying exported goods from another country.

The weaker a country’s currency the more of it people can get in exchange for their currency. Allowing importers to buy a lot more of those exported goods. Which helps the export economy of that nation with a weak currency. In fact having a weak currency is such an easy way to boost your exports that countries purposely make their currencies weaker. As they race each other to see who can devalue their currency more. And gain the biggest trade advantage (see Dollar Thrives in Age of Competitive Devaluations by A. Gary Shilling posted 1/28/2013 on Bloomberg).

In periods of prolonged economic pain — notably the 2007-2009 global recession and the ensuing subpar recovery — international cooperation gives way to an every-nation-for-itself attitude. This manifests itself in protectionist measures, specifically competitive devaluations that are seen as a way to spur exports and to retard imports.

Trouble is, if all nations devalue their currencies at the same time, foreign trade is disrupted and economic growth is depressed…

Decreasing the value of a currency is much easier than supporting it. When a country wants to depress its own currency, it can create and sell unlimited quantities. In contrast, if it wants to support its own money, it needs to sell the limited quantities of other currencies it holds, or borrow from other central banks…

Easy central-bank policy, especially quantitative easing, may not be intended to depress a currency, though it has that effect by hyping the supply of liquidity. Also, low interest rates discourage foreign investors from buying those currencies. [Japanese] Prime Minister Shinzo Abe has accused the U.S. and the euro area of using low rates to weaken their currencies.

“Central banks around the world are printing money, supporting their economies and increasing exports,” Abe said recently. “America is the prime example. If it goes on like this, the yen will inevitably strengthen. It’s vital to resist this.”

So a cheap and devalued currency really helps an export economy. But there is a downside to that. In some of these touristy areas with a really weak currency it is not uncommon for some people to offer to sell you things for American dollars. Or British pounds. Or Eurozone euros. Why? Because their currency is so week it loses its purchasing power at an alarming rate. So fast that they don’t want to hold onto any of it. Preferring to hold onto a stronger foreign currency. Because it holds its value better than their own currency.

When a nation prints money it puts more of them into circulation. Which makes each one worth less. And when you devalue your currency it takes more of it to buy the things it once did. So prices rise. This is the flipside to inflation. Higher prices. And what does a devalued currency and rising prices do to a retiree? It lowers their quality of life. Because the money they’ve saved for retirement becomes worth less just as prices are rising. Causing their retirement savings to run out much sooner than they planned. They may live 15 years after retirement while their savings may only last for 5 or 6 of those years.

Printing money to devalue a currency to expand exports hurts those who have lived most responsibly. Those who have saved for their retirement. Making them ever more dependent on meager state pensions. Or welfare. And when that’s not enough to cover their expenses they have no choice but to go without. We see this in health care. Where those soaring costs have an inflationary component. With the government squeezing doctors on Medicare reimbursements doctors are refusing some life-saving treatment for seniors. Because the government won’t reimburse the doctors and hospitals for these treatments. Or doctors will simply not take any new Medicare patients. As they are unable to provide medical services for free. And with their savings gone seniors will have no choice but to go without medical care.

The United States, Britain, Europe, Japan—they are all struggling to provide for their seniors. As China will, too. And a big part of their problem is their inflationary monetary policies. Coupled with an aging population. The Keynesians in these nations have long discouraged their people from saving. For Keynesians see private savings as leaks in the economy. They prefer people to spend their money instead of saving it. Trusting in state pensions and state-provided health care to provide for these people in their retirement. Which is why the United States, Britain, Europe and Japan are struggling to provide for their seniors in retirement. A direct consequence of printing too much money. And not letting people take care of their own retirement and health care.

Economics 101

A High Savings Rate provides Abundant Capital for Banks to Loan to Businesses

Time. It’s what runs our lives. Well, that, and patience. Together they run our lives. For these two things determine the difference between savings. And consumption. Whether we have the patience to wait and save our money to buy something in the future. Like a house. Or if we are too impatient to wait. And choose to spend our money now. On a new car, clothes, jewelry, nice dinners, travel, etc. Choosing current consumption for pleasure now. Or choosing savings for pleasure later.

We call this time preference. And everyone has their own time preference. Even societies have their own time preferences. And it’s that time preference that determines the rate of consumption and the rate of savings. Our parents’ generation had a higher preference to save money. The current generation has a higher preference for current consumption. Which is why a lot of the current generation is now living with their parents. For their parents preference for saving money over consuming money allowed them to buy a house that they own free and clear today. While having savings to live on during these difficult economic times. Unlike their children. Whose consumption of cars, clothes, jewelry, nice dinners, travel, etc., left them with little savings to weather these difficult economic times. And with a house they no longer can afford to pay the mortgage.

A society’s time preference determines the natural rate of interest. A higher savings rate provides abundant capital for banks to loan to businesses. Which lowers the natural rate of interest. A high rate of consumption results with a lower savings rate. Providing less capital for banks to loan to businesses. Which raises the natural interest rate. High interest rates make it more difficult for businesses to borrow money to expand their business than it is with low interest rates. Thus higher interest rates reduce the rate of job creation. Or, restated another way, a low savings rate reduces the rate of job creation.

The Phillips Curve shows the Keynesian Relationship between the Unemployment Rate and the Inflation Rate

Before the era of central banks and fiat money economists understood this relationship between savings and employment very well. But after the advent of central banking and fiat money economists restated this relationship. In particular the Keynesian economists. Who dropped the savings part. And instead focused only on the relationship between interest rates and employment. Advising governments in the 20th century that they had the power to control the economy. If they adopt central banking and fiat money. For they could print their own money and determine the interest rate. Making savings a relic of a bygone era.

The theory was that if a high rate of savings lowered interest rates by creating more capital for banks to loan why not lower interest rates further by just printing money and giving it to the banks to loan? If low interests rates were good lower interest rates must be better. At least this was Keynesian theory. And expanding governments everywhere in the 20th century put this theory to the test. Printing money. A lot of it. Based on the belief that if they kept pumping more money into the economy they could stimulate unending economic growth. Because with a growing amount of money for banks to loan they could keep interest rates low. Encouraging businesses to keep borrowing money to expand their businesses. Hire more people to fill newly created jobs. And expand economic activity.

Economists thought they had found the Holy Grail to ending recessions as we knew them. Whenever unemployment rose all they had to do was print new money. For the economic activity businesses created with this new money would create new jobs to replace the jobs lost due to recession. The Keynesians built on their relationship between interest rates and employment. And developed a relationship between the expansion of the money supply and employment. Particularly, the relationship between the inflation rate (the rate at which they expanded the money supply) and the unemployment rate. What they found was an inverse relationship. When there was a high unemployment rate there was a low inflation rate. When there was a low unemployment rate there was a high inflation rate. They showed this with their Phillips Curve. That graphed the relationship between the inflation rate (shown rising on the y-axis) and the unemployment rate (shown increasing on the x-axis). The Phillips Curve was the answer to ending recessions. For when the unemployment rate went up all the government had to do was create some inflation (i.e., expand the money supply). And as they increased the inflation rate the unemployment rate would, of course, fall. Just like the Phillips Curve showed.

The Seventies Inflationary Damage was So Great that neither Technology nor Productivity Gains could Overcome It

But the Phillips Curve blew up in the Keynesians’ faces during the Seventies. As they tried to reduce the unemployment rate by increasing the inflation rate. When they did, though, the unemployment did not fall. But the inflation rate did rise. In a direct violation of the Phillips Curve. Which said that was impossible. To have a high inflation rate AND a high unemployment rate at the same time. How did this happen? Because the economic activity they created with their inflationary policies was artificial. Lowering the interest rate below the natural interest rate encouraged people to borrow money they had no intention of borrowing earlier. Because they did not see sufficient demand in the market place to expand their businesses to meet. However, business people are human. And they can make mistakes. Such as borrowing money to expand their businesses solely because the money was cheap to borrow.

When you inflate the money supply you depreciate the dollar. Because there are more dollars in circulation chasing the same amount of goods and services. And if the money is worth less what does that do to prices? It increases them. Because it takes more of the devalued dollars to buy what they once bought. So you have a general increase of prices that follows any monetary expansion. Which is what is waiting for those businesses borrowing that new money to expand their businesses. Typically the capital goods businesses. Those businesses higher up in the stages of production. A long way out from retail sales. Where the people are waiting to buy the new products made from their capital goods. Which will take a while to filter down to the consumer level. But by the time they do prices will be rising throughout the economy. Leaving consumers with less money to spend. So by the times those new products built from those capital goods reach the retail level there isn’t an increase in consumption to buy them. Because inflation has by this time raised prices. Especially gas prices. So not only are the consumers not buying these new goods they are cutting back from previous purchasing levels. Leaving all those businesses in the higher stages of production that expanded their businesses (because of the availability of cheap money) with some serious overcapacity. Forcing them to cut back production and lay off workers. Often times to a level below that existing before the inflationary monetary expansion intended to decrease the unemployment rate.

Governments have been practicing Keynesian economics throughout the 20th century. So why did it take until the Seventies for this to happen? Because in the Seventies they did something that made it very easy to expand the money supply. President Nixon decoupled the dollar from gold (the Nixon Shock). Which was the only restraint on the government from expanding the money supply. Which they did greater during the Seventies than they had at any previous time. Under the ‘gold standard’ the U.S. had to maintain the value of the dollar by pegging it to gold. They couldn’t depreciate it much. Without the ‘gold standard’ they could depreciate it all they wanted to. So they did. Prior to the Seventies they inflated the money supply by about 5%. After the Nixon Shock that jumped to about 15-20%. This was the difference. The inflationary damage was so bad that no amount of technological advancement or productivity gains could overcome it. Which exposed the true damage inflationary Keynesian economic policies cause. As well as discrediting the Phillips Curve.

Week in Review

Central banks have caused most of our financial woes today. Easy credit created a frenzy of buying. Pushing asset prices skyward. America’s subprime mortgage crisis was caused by easy credit. Well, that, and bad government policy like forcing lenders to lend even to people who were unqualified. And they had their government sponsored enterprises (GSE), Fannie Mae and Freddie Mac, unload those toxic mortgages to unsuspecting investors. You add this to the easy credit of America’s central bank, the Federal Reserve, and it created an incredible housing bubble. That just didn’t burst. It exploded. Sending the U.S. into the greatest recession since the Great Depression. The Great Recession.

As housing prices fell back to earth homeowners found themselves underwater in their mortgages. Some refinanced. Some just walked away. Some went through foreclosure. Leaving the country littered with foreclosed homes. And all of this financial destruction was brought to us courtesy of the Federal Reserve and their easy credit. Despite all of this devastation our central bank has caused us some people still think that central banks can stimulate us out of the Great Recession. Perhaps they’ll finally learn the folly of their thinking (see Roubini: My ‘Perfect Storm’ Is Unfolding Now by Ansuya Harjani, CNBC, posted 7/9/2012 on Yahoo! Finance).

“Dr. Doom” Nouriel Roubini, says the “perfect storm” scenario he forecast for the global economy earlier this year is unfolding right now as growth slows in the U.S., Europe as well as China.

In May, Roubini predicted four elements – stalling growth in the U.S., debt troubles in Europe, a slowdown in emerging markets, particularly China, and military conflict in Iran – would come together in to create a storm for the global economy in 2013…

Policy easing moves by the European Central Bank (ECB), Bank of England (BoE) and the People’s Bank of China (PBoC) last week did little to inspire confidence in global stock markets…

Bill Smead, CEO of Smead Capital Management, agrees that there is little central banks can do arrest the global slowdown.

Last week, he told CNBC that there is “virtually zero chance” that pump-priming by central banks will succeed, suggesting that policymakers should instead let the economic bust work itself through the system.

Yes. We should let the economic bust work itself through the system. Because that’s what recessions are supposed to do. That’s why we call them corrections. When rising prices create asset bubbles recessions come along and correct these prices back to where they should be. Where the market would have had them had it not been for all of that easy credit.

Recessions aren’t pleasant. But it’s the price we must pay. Especially when we interfere with market forces to keep interest rates artificially low to stimulate economic activity. Because the economic activity they stimulate is as artificial as the interest rates. People don’t base their purchasing decisions on supply and demand. They base them on the availability of easy credit. Where people say things like, “I had no intention of buying a 3,000 square foot home for me and my wife but at these mortgage rates I’d be a fool not to. And wouldn’t a Cadillac look just great in the driveway? At these low interest rates I can afford both. I mean, it’s not like I’m going to lose my job or anything.”

Of course people do lose their jobs. And their homes. And their cars. What happens then? Why, we have a subprime mortgage crisis. And a Great Recession. That’s what.

Week in Review

The woods are lovely, dark and deep. But I have promises to keep. And miles to go before I sleep. And miles to go before I sleep. Lines from a poem by Robert Frost. For some reason this came to me as I read about the never-ending crisis that is the sovereign debt crisis in Europe. And the Eurozone. For the Euro is lost in those dark and lovely woods. Woods that are so deep that it will never find its way out. And the only kind of sleep the Euro is going to get is the kind you don’t wake up from (see Britons face £5bn bill to help out Spanish as fears grow that Madrid will have to ask IMF for €300billion bailout by Hugo Duncan And James Salmon posted 6/1/2012 on the Daily Mail).

British taxpayers could be forced to stump up another £5billion to rescue Spain as the crisis in the eurozone spirals out of control.

Fears are mounting that Madrid will have to ask for an emergency bailout of up to £300billion as it struggles to prop up its basket-case banks.

A third of that money could come from the International Monetary Fund – including around £5billion from the UK, even though Britain is not in the eurozone.

But growing doubts over how the Spanish government will finance the £15billion needed to rescue Bankia, one of its biggest lenders, have raised fears that it will follow Ireland, Greece and Portugal in requiring a bailout from Europe and the IMF.

This week US investment bank JP Morgan warned a joint rescue of Spain could cost around £300billion.

The Spanish banking system has been crippled by nearly £150billion in toxic property loans.

At the heart of the sovereign debt crisis in Europe is debt. They have way too much of it. So much that the odds are not good that they will ever be able to repay it. Which makes people very reluctant to loan them any more money. It’s like loaning a friend money who already owes you a lot of money. Do you loan him more money? It just may help him turn his life around. Start anew with a new job. Earning enough money to support himself and pay you back. That’s one possibility. Then there’s the possibility he may just blow the money on booze, drugs and women. You know he’s just going to spend whatever else you loan him. And not pay any of it back. So it would be rather foolish to loan him more money.

This is the decision facing the people who could attempt to bail out those in the Eurozone. They’ve already loaned them a lot of money. So these in-trouble countries can sustain the government spending their current tax revenue can’t support. But the deal was to cut back that spending so they can live on what their tax revenue CAN support. But there’s only one problem. The people of these countries reject calls for them to live within their means. And have had enough of austerity. And that’s a big problem. Because if they don’t live within their means they will perpetuate the sovereign debt crisis. As they will always need to borrow more money to pay for the things that their tax revenue can’t afford. Until the day this house of cards collapses. And the longer it goes on the more money people will lose in bad loans to these in-trouble countries.

The central problem in this crisis are bad loans. Caused by the easy credit policies of central banks to loan money to anyone so they can buy a house. All this easy credit caused housing booms in countries all around the world. And housing bubbles. Then the bubbles burst. Leaving countries with debt crises as toxic mortgages weakened banking systems everywhere. And still Keynesian economists are urging central banks to repeat this reckless lending behavior again to stimulate economies. And to bail out the Eurozone. The problem is that the central banks have so destroyed their economies no one is borrowing money. Or spending money. Because no one thinks the worst has passed. And businesses and private citizens have learned the lesson from the great debt crisis we’re going through everywhere. Too much debt is a bad thing. And are refusing to take on new debt. And using what income they have to pay down existing debt. Contrary to all Keynesian doctrine. For they want reckless and irresponsible spending. Because they believe only spending is good.

Politicians and central bankers said the situation in the eurozone was unsustainable and drastic action was needed to prevent the ‘disintegration’ of the single currency.

They spoke out as European leaders scrambled to stop the financial crisis in Spain spiralling out of control and infecting other countries such as Italy…

Mario Draghi, president of the European Central Bank, said the eurozone was unsustainable in its current form.

In his sharpest criticism yet of eurozone leaders’ handling of the crisis, he said the European Central Bank could not ‘fill the vacuum’ left by governments in terms of economic growth or structural reforms.

So, no, more easy credit isn’t the solution. Countries must live within their means. Which means adopting austerity measures. And find ways to achieve real economic growth. Not the kind that leads to bubbles. Or sovereign debt crises. And the best way to generate real economic growth is with tax cuts. Cutting spending as needed so they spend only what their tax revenue can afford. They must stop running deficits. And stop borrowing money. (Good advice for the United States as well). As the private sector economy picks up because of a more business-friendly tax structure they will create jobs. So all of those government workers who lost their jobs in the public sector can get new jobs in the private sector. Whose salaries and benefits will not have to be paid for by more government borrowing. If they adopt pro-growth policies like this the international community may still be able to help them. And save the Euro. But will they? With all of that public opinion against any more austerity? Don’t know. Probably not.

It’s unlikely that the Euro will ever find its way out of the woods. For these woods are scary, dark and deep.

IMF chief Christine Lagarde on Thursday urged member countries to quickly sign off on an agreement last year to double IMF resources and give under-represented nations, such as China, greater voting power in the global lender.

The changes to members’ quotas, which determine how much each country contributes to the IMF and their voting shares, are critical as a euro zone debt crisis escalates and is set to slow global growth in 2012…

As of December 12, just 53 countries, holding 36 percent of total IMF quotas, had approved the increases. Approval by members holding about 70 percent of quotas is needed to implement the changes. Some countries require their legislatures to authorize the changes.

The measure still requires approval by the U.S. Congress, where Republicans are taking aim at any IMF move to bail out troubled euro zone countries, saying they don’t want American funds involved.

IMF resources? You know what that means. More of our money. So they can give it to other people. Like those in the Eurozone. Where they won’t cut back on their government spending and live within their means. Instead they want us to cut back on our spending. So we can give them our tax dollars.

With only about half the votes they need to increase their spending (and our taxation), it doesn’t look good for the IMF right now. You see, the problem is that it’s just not one country in need of assistance. Right now governments all around the world are living beyond their means. Even the United States has entered the fraternity of nations who irresponsibly live beyond their means. Which makes it difficult to help pay for other nations. Because we’ll just push ourselves closer to where they are now. And once we do who will be there to bail out us?

Keynesian economists say no big deal. Just print more money. Which is what central banks are for. But it was those central banks that created the crisis in the Eurozone in the first place. And doing more of what gave you a problem is not likely to solve that problem. No matter what the Keynesians say.